Mandatory Medigap Standards Reduce Insurance Protection

"On net, the minimum standards are associated with an overall decrease in insurance
coverage and thus an increase in individuals' exposure to out-of-pocket medical expenses."

Minimum government standards on private medical insurance for the elderly have led to
lower coverage than would have been the case in the absence of regulation, according to new
research from the NBER. In Minimum Standards and InsuranceRegulation: Evidence from
the Medigap Market,
(NBER Working Paper No. 8917) author Amy Finkelstein finds that
minimum standards imposed on "Medigap" insurance 25 years ago resulted in a decline in voluntary
coverage of the regulated insurance of about 25 percent. This finding is of particular interest because
minimum standards continue to be applied or proposed in many different health insurance markets,
including state-imposed minimum standards on employer-provided health insurance and federal
proposals for a "Patients' Bill of Rights" that would impose minimum standards on Health
Maintenance Organizations (HMOs).

Medigap insurance fills the gaps in coverage left by Medicare, the U.S. public health
insurance program for the elderly. These include co-payments and deductibles; services that
Medicare covers only partially, such as home nursing; and health services that Medicare does not
cover at all, such as outpatient prescription drugs. In 1977, prior to the imposition of minimum
standards, Medicare paid for just under half of all the health care expenses of elderly Americans. As
a result, two-thirds of Medicare beneficiaries had private insurance to supplement Medicare, roughly
half through employment-based ("group") policies and half through individual ("non-group")
policies.

In the late 1970s and early 1980s, almost all the states followed a federal "recommendation"
to impose minimum standards on the non-group Medigap market. These specified certain gaps in
Medicare coverage that any non-group Medigap policy must cover, including coverage for co-payments on hospital days covered by Medicare, coverage of 90 percent of the cost of hospital stays
beyond 150 days -- at which point Medicare coverage stops -- for at least another 365 days, and
coverage of co-payments for physician visits. Data from the 1977 National Medical Care
Expenditure Survey (NMES) indicate that, prior to the enactment of the regulations, less than 7
percent of non-group policies would have met the minimum standards, and that to come into
compliance, these policies would have to substantially increase the amount of insurance provided.
However, the legislation did not require that individuals purchase Medigap insurance; it also left
unregulated the price of the policy and the provision of additional, non-mandated benefits.

Finkelstein uses information from the National Health Interview Surveys to examine the
effect of the minimum standards on the likelihood of being covered by non-group Medigap
insurance. She shows that the introduction of the minimum standards was associated with a 15
percent decline in non-group coverage in the first two years, and a long-run decline of 25 percent.
There is no evidence that individuals switched to other forms of unregulated insurance.
Furthermore, although few non-group policies would have met the minimum standards prior to
their implementation, many of these policies had provided additional benefits - such as prescription
drug coverage or coverage for care in a skilled nursing facility - not required by the minimum
standards. The evidence suggests that the minimum standards also were associated with a substantial
reduction in coverage of these non-mandated benefits for those who retained non-group Medigap
insurance.

The motivation for minimum standards is a concern that individuals lack sufficient private
insurance. Underinsurance may be the result of consumers' misinformation about their medical
needs (and about the amount of coverage provided through the public Medicare program), or the
result of what economists call "adverse selection" - that individuals know more about their medical
needs than insurance companies do. Minimum standards attempt to increase insurance coverage by
requiring individuals who remain insured to purchase benefit coverage that they would not
otherwise have purchased.

>Finkelstein calculates the increase in insurance coverage for those who remained insured and
therefore had to upgrade their coverage to comply with the minimum standards. She then compares
this to the decreases in insurance coverage for those who chose instead to drop all coverage and the
decline in non-mandated benefits among those who kept some insurance coverage. She finds that,
on net, the minimum standards are associated with an overall decrease in insurance coverage and
thus an increase in individuals' exposure to out-of-pocket medical expenses. Moreover, Finkelstein
concludes that the problem of adverse selection exacerbated the magnitude of the declines in
insurance coverage produced by the minimum standards.

These results highlight the fact that policymakers need to think carefully about the nature of
the market failure that motivates the regulation, and ask whether government intervention might
make the problem worse rather than better. In this instance, while the problem of adverse selection
might suggest the need for government intervention, it also exacerbated the negative consequences
of this intervention.

-- Andrew Balls

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